Little Change with Unbundling


New York, NY – Over eighteen months ago, the FSA took the courageous first step of mandating that asset managers report to pension fund clients how much of their commissions were being spent on execution and research.

Since then, a great deal of discussion has taken place about the positive and negative impacts of commission transparency and the resultant unbundling that would take place.

And while we believe that commission transparency and unbundling is an extremely important development for investors, we are not convinced that the current state of affairs is any better for investors than we had in a completely bundled environment.

A Flawed Understanding

The primary reason that the current form of unbundling is not much different than the way business was done before is due to a flawed understanding of what money managers use their equity commissions to pay for.  Some of these services include:

  • Agency execution services
  • Capital Commitment
  • Access to the IPO Calendar
  • Prime Brokerage Services
  • Research Services
  • Management Access
  • Institutional Sales Coverage

However, the FSA was hoping to create a new environment where investment managers used equity commissions only to pay for “execution” and “research” services.  Thus, the question remaining is, “Have asset managers stopped using equity commissions to pay for non execution and non research services?”

The Math Just Doesn’t Seem To Work Out

One way to look at this issue is to assess how much European and US asset managers say they value execution services as they establish their Commission Sharing Agreements (CSAs).

A number of market surveys show that money managers are currently allocating between 40% to 60% of their commission to execution services (with the remaining allocated to research).

Based on an average full services equity commission of 4 cents per share, this means that money managers are willing to pay between 1.6 cents (4 cents per share x .40) to 2.4 cents (4 cents per share x .60) per share for execution services.

However, this just doesn’t seem to make sense when most ECNs will provide low touch execution at between .5 cents to 1.0 cents per share.  This means that money managers are willing to overpay brokers 200% to 300% for their execution services.  There must be some reason that intelligent investment professionals would make such a seemingly illogical choice.

The Current Situation

One explanation for this strange decision is to ascertain how much money managers say they are spending on the valuable services they receive from their brokers.  Based on a recent Greenwich Associates study, asset managers spent their commissions on the following services:

2006 Commission Allocation For Specific Services

US Institutions

European Institutions

Broker Research. Corporate Access & Sales Coverage



Sales & Trading Agency Execution



Soft Dollar Commissions



Capital Commitment



Commission Recapture



Step Outs



New Issues






As a result, US institutions said they spent 51% on research (42% on broker research, corporate access, and sales coverage and 9% on soft dollars), 28% on execution services, and an additional 7% on capital commitment.  European institutions, on the other hand, spent 61% on research, 30% on execution, and 4% on capital commitment.

It is important to realize that this means that in the US, asset managers said they spent 14% of the average equity commission on non-execution and non-research services, whereas in Europe, this figure is 9%.

Based on an average full services equity commission of 4 cents per share, this would mean that US money managers are spending .56 cents per share on these “other” non execution or non research services (4 cents per share x .14).

The Upshot

So why does it look like asset managers are significantly overpaying for their execution?  The data above suggests a clear answer.  Money managers receive a wide range of valuable services from their brokers.  However, due to the FSA’s efforts in this area, managers are only allowed to allocate their commissions between two types of services – execution and research.

Consequently, we suspect that money managers are incorrectly categorizing their non execution services to ensure they appropriately reward their brokers for providing these services.  As a result, some money managers are counting these expenses as “execution” in order to pay their brokers (hence the high payment for execution services discussed above).
However, we would not be surprised if some asset managers are also categorizing these non-execution and non-research expenses as research.  According to Greenwich Associates, European institutions are currently paying their CSA brokers 21% of the overall commission in compensation for their proprietary research.  This is only slightly less than the 26% that large European asset managers are paying out to all third-party research providers as part of their CSA arrangements.

Unfortunately, it is impossible to ascertain exactly what money managers are actually spending on execution, research, and these other valuable services.

Ultimately this obfuscation means that investors will never get good information about how their money managers are spending their commission dollars.  This should lead us to ask ourselves, “Are we much better off with unbundling as we were in a bundled world?”

Comment by Name:
The non-execution or non-research cost should be .44 cps since 5% is being recaptured by (refunded to) the underlying account holder.


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